Reflections on a Wandering Life.....

Wednesday, October 01, 2008

The world watches as the US Congress tries to decide what to do about the current market crisis. Yesterday, the vote against the bail-out happened too late to hit the morning paper. But this morning, it was all over the front page. That in spite of the fact that today is National Day in China. Granted, China Daily is a paper designed to present China to foreigners, so I guess it's understandable. Still, it reflects the level of importance China attaches to the current crisis. China owns a good portion of the US government, and is heavily invested in the market. The hurry with which this whole bail-out has been put together, combined with Nancy Pelosi's astounding decision, at the last minute, to make some political hay by turning the whole thing into a referendum on the Bush presidency, combined to give the waverers an excuse to bail out of the bailout.

I must admit to having mixed feelings about it myself. I am torn between the realization that the current crisis demands very decisive action to restore stability to the market, and a desire to see the market get the lickin' it deserves. We always say that those who take great risks are entitled to larger rewards. But now we have a situation where the risk takers went to far, and they are asking the government to rescue them. Doesn't seem right to me. According to the rules of the game, they should be required to take their losses, shouldn't they? Did they offer to share their profits with the country when they were winning?

And I'm not just talking about Wall Street. I must be old fashioned, but I cannot imagine what unearthly insanity would posses someone to buy a house with a variable rate mortgage--allowing the other guy to change the terms of the deal after the thing has been signed. It now appears that many homeowners across America were taking out mortgages not on the value of their homes, but on the eventual value of their homes. That's not investment. That's speculation. It's hard not to feel some sympathy for families who are losing their homes, but can you imagine how things would be different if everyone who purchased a home accepted only those terms that they would be able to meet regardless of what happened to the market price of their homes? Ironically, if everyone had done that, the prices probably would not have fallen, at least not as much as they did.

Warren Buffet gives two basic rules for investment:

1. Don't loose money.
2. Don't forget Rule #1.

It may seem overly simplified, but it does illustrate the basic principle of investment, in sharp contrast to the way speculators operate. Speculators "invest" money expecting to lose (you win some, you lose some), but hoping that they will win more often than they lose. Sometimes they get lucky and the gamble pays off. And other times....

Warren Buffet has always been a stickler about restricting his money to investment, and avoiding speculation like the plague. He only buys stuff that has actual value. True, he has missed some bonanzas. But he has also gained steadily at a rate that has been estimated to be the equivalent of putting your money in a savings account at 22% interest.

Real estate speculation is tempting, and it is quite common here in Beijing. If there is a property for sale at 700,000 RMB and you know it is overpriced, but you firmly believe that it will be selling for 800,000 RMB a year later, the temptation is to buy it, hold it for a year, and then sell it and collect the profit. People who do this don't care about real value, because they're not buying real estate to use it, they are buying it to make money. It's pure speculation. The problem with that game is that it always (and I do mean always) fails at some point, and the person who buys right before the point of failure loses and loses big.

The problem now, though, in Beijing, and I suspect also in America, is that there are many people buying overpriced real estate who really do need a place to live, and they are taking out huge loans in the hope that if they live in the place long enough, the real value will "catch up" with the market value, or at least the amount that they have the place mortgaged for, so that they don't lose their shirts. Oh, man, that is just way too scary. Folks here in Beijing who did that a few years ago are getting by with it (so far), but when you get a whole lot of people doing that in any economy, it is a prescription for disaster.

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